Educational Articles

Analyzing the Thrift Industry

Robert Mitkowski

Items in the Array

In the thrift format, Gross Income is analogous to sales or revenues of an industrial company. It consists of the interest income generated by a thrift’s earning assets, supplemented by noninterest (mainly fee) income. Note that securities industry terminology has become more general in recent years, broadening to include ``revenues’’ even for financial companies. For financials, that term has come to mean net interest income (interest income less interest expense) plus noninterest income. But our thrift page still uses the traditional Gross Income line item.

For illustrative purposes, it’s useful to keep in mind that, if there were no balance-sheet changes, the Gross Income figure would rise or fall in relation to which way interest rates were headed. But thrifts are usually adding assets from one year to the next, pushing gross income higher, particularly when rates are rising, and cushioning the fall when yields are dropping.

Changes in Gross Income clearly affect two of the expense ratios on the page, Interest Cost to Gross Income and G&A (General & Administrative) Expense to Gross Income. G&A Expenses look higher in proportion to Gross Income when the top line falls, but that doesn’t tell the whole story. It is better to compare one company’s expense ratio to another’s to see who is the most efficient. Bear in mind that running more product lines pushes up expenses.

Meanwhile, a declining percentage of interest costs is a definite plus for the bottom line, although it comes with a caveat. Lower interest rates usually signal trouble in the broader economy that could well also mean slower asset growth and more troubled loans. Historically, the best time to invest in thrifts has been when interest costs are falling as a percentage of gross income. That hasn’t been the case lately, though, owing to broader concerns regarding the health of the financial sector.

Performance Measures

One quick way to tell how well a thrift is doing is to look at its Yield-Cost Margin, or more simply known as the interest rate spread. That figure is shown in the Earnings Factors box near the middle of the left hand side of the page. Wider spreads are better, of course. Investors can get the feel of where spreads have been the past couple years, where they are now, and their makeup and composition, from our data. A Yield-Cost Margin of 3% is a healthy number, although thrifts can make do with less if they run a tight ship. For example, Hudson City Bancorp (HCBK) has historically compensated for lower margins with strong volume growth.

For thrifts, the Return on Total Assets and Return on Shareholders’ Equity tend to mirror what’s going on with earnings, but with a slightly different twist. The direction of these indicators is usually taken by Wall Street to be more important than their absolute levels. The industry benchmark for Return on Assets is 1.00% and for Return on Shareholders, a low- to mid-teens percentage is considered very good. Those hurdles have proven difficult to clear lately, in view of equity issuances to boost capital, falling asset yields, and higher credit costs.

Perhaps no other statistic has risen more in importance in recent times than Problem Assets to Loans, following the deep recession that occurred from late 2007 to the middle of 2009. Lenders had enjoyed a long period of stellar loan quality for more than 10 years prior to that. The current industry average of about 2.0% for Problem Loans to Assets isn’t alarming, in and of itself. But investors are concerned because that number hasn’t peaked. Sentiment toward the group would very likely improve once problem assets begin receding, provided no hike in interest rates is looming.

At the time of this writing, the author did not have positions in any of the companies mentioned.